Rural Credit Cooperatives In India


This case was written by Bidhan Parmar (MBA/PhD ’09) under the supervision of Wei Li, Associate Professor of Business Administration. It was written as a basis for class discussion rather than to illustrate effective or ineffective handling of an administrative situation. Copyright © 2007 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an e-mail to No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of the Darden School Foundation. Rev. 8/08.




One Sunday morning in July 2006, Mohan R. Narayan was keeping his eye on the weather. Lately the seasons were unpredictable. During the usual monsoon season the clouds had refused to rain, and now during peak harvesting time, temperatures were flaring. Like a child throwing a temper tantrum, sometimes the weather just refused to do what it was supposed to. Narayan knew that erratic weather was an ominous sign.

Narayan was a leading economist at a prestigious Indian university outside New Delhi.

Recognized for his work on banking-sector development, he had developed a reputation for being strong-willed through his staunch advocacy of financial discipline and free market competition. Recently, the Indian Congress had asked him to be a member of a distinguished committee whose goal was to analyze and make policy recommendations about India’s Cooperative Financial Institutions (CFIs), which included organizations such as credit unions and cooperative banks. On one hand, Narayan was enthusiastic about the job; it was an opportunity to help millions of rural poor and to have a positive effect on the country. On the other hand, he knew the system had a long history of overregulation, financial laxity, and corruption. Creating an actionable and clear strategy would be no easy task.

Narayan flipped past the weather report in the newspaper, and on page five saw a story

that shocked him. In villages in the western state of Gujarat, 100 farmers had committed suicide in the last week by drinking pesticides.1 The farmers reportedly had been heavily in debt to money-lenders. Because the recent drought had yielded little harvest, they had no money to get out of debt, and the poor farmers found themselves with no hope for the future or reason to continue living.

Six hundred miles away, Puja Mehta was in crisis mode. She was the director of the

credit cooperatives in the 15th district in the state of Gujarat. Seven farmers had committed suicide in the last week in her district alone and she did not know what to do. How could she

1 This fictitious example is based on real events reported in the New York Times on September 9, 2006, in an

article entitled “On India’s Farms, a Plague of Suicide.” html?ex=1316318400&en=5b14a09e800d407c&ei=5088&partner=rssnyt&emc=rss, (accessed 12 March 2007).

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members of the cooperative



console their families? What would she tell the other members of the cooperative? When she was appointed to this job by her uncle, a local politician, she never thought it would be so gruesome. Over the past 15 years, Mehta had seen a lot of things. She saw firsthand that access to credit could empower the rural poor. Credit cooperatives were a way to get aid to those who needed it most without resorting to the usury of money-lenders. Since the country had liberalized its markets to international trade in agriculture in the early 1990s, she noticed that farmers were hit the hardest. They had seen the prices of their produce fall, and in order to compete, they had to use genetically modified seeds marketed by Monsanto that were substantially more expensive. With unpredictable weather, crop yield was also volatile.

Every now and again, the government would try to encourage the cooperatives to be more profitable, but in time, they would reverse course. Mehta understood the cooperatives to be a social institution, which would crumble without government support. If the cooperative were able to get more money to the poor, it could make a bigger impact. She wondered if this latest round of suicides would spark the government to appropriate more funds to CFIs. She was certain that something had to be done. Cooperative Financial Institutions (CFIs)

CFIs comprised a broad category of institutions where members pooled their own resources to create a bank where they could deposit their savings and get credit. Governments around the world from Argentina to India had supported and encouraged the growth of various credit unions and credit cooperatives as a way for the poor to help themselves out of poverty. CFIs were distinct from microfinance institutions because they generally served clients with some savings or property and did not rely as much on donor support.2

Cooperatives were started simultaneously in Britain and Germany in 1844 during the

Industrial Revolution. The first cooperative in Britain was a group of 28 weavers, called the Rochdale Society of Equitable Pioneers, who pooled their resources to create a cooperative store that sold flour, oatmeal, sugar, butter, and candles. The members pledged to better their lives by pooling capital to acquire land for food production and provide housing and work for members. In Germany, the first credit union was created as a response to crop failures and the usury of money-lenders. These “people’s banks” mainly helped skilled workers borrow for business purposes. Both these movements laid the foundations for cooperatives in other countries.3

The cooperative institutions in India had a three-tiered structure (see Exhibit 1). At the

grass-roots level were village banks called Primary Agricultural Credit Societies (PACS). There were 112,000 PACS, roughly one for every six villages. They had the largest rural penetration with membership estimated at 120 million people, but only 50% of these members actually

2 Carlos E. Cuevas, Klaus P. Fischer, “Cooperative Financial Institutions Issues in Governance, Regulation,

and Supervision.” World Bank Working Paper No. 82, 2006. The International Bank for Reconstruction and Development, The World Bank.

3 “The Story of Credit Unions,” (accessed 12 March 07).

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District Central Cooperative Banks



borrowed from the PACS (see Exhibit 2).4 For the PACS to be regulated and properly funded, the government created two additional levels of cooperative banks. The second-tier banks were the 367 District Central Cooperative Banks (DCCB), and at the top tier, there were 30 State Cooperative Banks (SCB). The SCB did most of the regulation and monitoring of the CFI sector; therefore, rules, regulations, and norms varied from state to state. The Reserve Bank of India (RBI) and the National Bank for Agricultural and Rural Development (NABARD) made policy recommendations and kept records of government spending in the CFI sector.

By the early 1990s, CFI accounted for more than 60% of total agricultural credit in India; by 2007, that share had fallen to 34%, despite a 10% annual increase in the amount of absolute disbursement.5 The loss in market share had been made up by commercial banks that took the more financially secure clients out of the CFI system (see Exhibit 3). The farmers left in the system had fewer assets to serve as collateral for loans and less savings to deposit in the cooperative banks.

The Indian government had long appreciated the link between improving access to

financing and the reduction of poverty. Of the 26% of the population (260 million people) who were classified as living below the poverty line, 74% lived in rural areas. According to the World Bank’s National Council of Applied Economic Research, “rural banks serve primarily the needs of the richer rural borrowers: Some 66% of large farmers have a deposit account; 44% have access to credit.”6

Given the concentration of poverty in rural areas, the expansion and success of rural

banking had become a focal point in the fight against poverty. Since the early 1980s, the volume of credit flowing through CFI in India had increased, but the financial health of these organizations had also declined(see Exhibits 4 and 5).7 As of 2003, the accumulated losses of PACS were estimated at $10.4 billion. History of the Cooperative Movement in India8

The Indian government had been heavily involved in the development and regulation of CFI since their inception in the early 1900s. Witnessed cycles of regulation and laxity, Indian CFI evolved through four distinct phases.

In the 1900s, officers of the British Indian Empire recognized that high lending rates for

the poor increased poverty. They imported a European (German) model of credit cooperatives and were convinced that by breaking the cycle of indebtedness moneylenders create, the poor

4 A. Vaidyanathan, “Report of the Task Force on Revival of Rural Cooperative Credit Institutions,” Department for Cooperative Revival and Reforms (DCRR), 04 February 2005, Section 3.09 departmentforrivalsreforms_task_force.asp (accessed 12 March 2007).

5 Vaidyanathan, Section 3.17. 6 Priya Basu, Improving Access to Finance for India’s Rural Poor (World Bank, 2006), xv. 7 Vaidyanathan, Section 3.29. 8 Vaidyanathan, Chapter 2.

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the British colonial government



would be freed from poverty. In 1904 and again in 1912, the British colonial government passed legislation encouraging and promoting cooperatives. The state began its protection of cooperatives in this period. In 1915, the Maclagan Committee advocated that “there should be one cooperative for every village and every village should be covered by a cooperative.” As interest and momentum began to build around the idea of CFIs, the activities of actual CFI diversified well beyond agricultural credit—which led to debates about whether there should be single (financial) or multipurpose cooperatives in a single village.

The second phase beginning in 1930 was marked by the increased role of the Reserve Bank of India (RBI). The RBI emphasized the creation and fortification of CFIs and encouraged them to be financially viable. The RBI also began lending credit to provincial cooperatives for seasonal agricultural operations and fluctuations. In this period, there was less promotion and growth of CFIs than in the first phase. A majority of CFIs were found to have frozen assets due to low repayment rates. The government liquidated these frozen assets and adjusted cooperatives’ claims to the payment abilities of their members.

Having considered the CFIs too small to have the scale economies needed to withstand market competition and to fulfill their social obligations, the government offered CFIs protection from their main rivals—commercial banks—and simultaneously sought to increase their scales of operation by pooling resources among grassroots CFIs through bureaucratic intervention. For some, this was the beginning of state interference in the management of CFIs and “the consequent erosion in the credit discipline of the members.”

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